It’s that time of the year when ‘experts’ throw around intimidating economic jargon to ‘advise’ the government and ostensibly enlighten us all on what’s wrong with our economy. Starting today, we bring to you well-known commentator on political and economic affairs S Gurumurthy’s three-part series, Indian Economy for Dummies, to make the subject intelligible and less intimidating. In the first part, he lays bare hidden truths behind some obvious facts that are the most difficult to detect and missed in the Indian economic discourse, policy and budget-making.
Truths hidden in facts about India that are obvious to the naked eye are missed in Indian economic discourse and budget-making. Do you know that the share of corporate sector in national GDP is just about 15% after drawing Rs 18 lakh crore credit? And that it created just 2.8 million jobs? The informal sector on the other hand generates 90 per cent of jobs in India
>>Related: Indian Economy for Dummies – II
Obvious fact, hidden truth
Look at some of the obvious facts about the Indian economy. Household savings have been rising post-liberalisation despite average interest rates falling since the 1990s. Most of household savings get into low-yielding bank deposits even though the Indian stock market has been growing at a compounded rate of 14 per cent a year since 1991. The growth in Indian per capita spending is slower as compared to the rising per capita income despite the intense consumerist agenda powered by liberalisation. Indian households trust banks, gold and properties and not stocks as much. Indian public and private — domestic and foreign, listed and unlisted — corporates put together improved their share of national GDP from a mere 12% in 1991 to a mere 15% — by just 3% in over two decades of a policy regime that red-carpeted the corporates, particularly foreign. The share of listed corporates in the national GDP is just about 5% even now. And the share of the companies figuring in the Sensex is minuscule. These obvious facts hide some basic truths about the Indian economy. But economists tend not to see the hidden truth behind obvious facts. They even blame the obvious facts for the economic ills of India. They fault Indians for not investing in stocks and for not producing risk capital. Indians invest in gold, thus making their savings unproductive, they charge. And yet, they turn blind to the under-performance of corporates altogether. Hidden truths behind obvious facts are the most difficult to detect. Because unless one asks why it is so, the truth behind the obvious will remain hidden. Only critical minds can ask why and get at the truth — like only Isaac Newton did not blame the apple for falling but asked why apples were falling and brought out the truth of gravitational pull hidden in the obvious fact of the falling apple. The truths hidden in facts about India that are obvious to the naked eye are missed in Indian economic discourse. And therefore in policy and budget making in India. The elitist nature of the guild of economists in India, who look to the West for handling the problems of India, is the reason for their ignorance about the hidden truth behind obvious facts.
The profession of economists had become so respectable in the 20th century West that economists became more respected than elected leaders, who even fear them. After the 2008 crisis, The Economist magazine [July 19-24, 2009] wrote, “On the public stage, economists were seen as far more trustworthy than politicians” but added, “in the wake of the biggest economic calamity in 80 years that reputation had taken a beating. In the public mind, the arrogant profession has been humbled.” But despite that, economists still have an intimidating influence over politicians. But who are economists and what is economics? Decades ago  J K Galbraith, a celebrated economist himself and a diplomat, wrote that economic services are ‘ideological’ and ‘consist in instructing several hundred thousand students every year’; the instruction is ‘inefficient’ but nevertheless ‘implants imprecise, but serviceable, set of ideas’ in the minds ‘of even those who are opposed to it’; they are ‘led to accept what they might otherwise criticise’. Galbraith concluded: “As such, it serves as a surrogate for the reality for legislators, civil servants, journalists, television commentators, professional prophets, — all, indeed, who speak, write or act on economic questions”. The subject of economics and the guild of economists could not have been demystified more eloquently. What Galbraith meant is that the profession of economists is an oligarchy which perpetuates its own agenda by enforcing conformity within, not just to dominate over the elected political system, but to direct the whole public discourse. Is it not time then that the subject, economics, which has been monopolised by a self-perpetuating set of experts, is demystified, made less intimidating and less elitist? Is it not time that all intelligent people are made to understand the hidden truth behind obvious facts? The popular book series ‘For Dummies’, which claims to present non-intimidating guides for readers new to different subjects, deals with all subjects under the sun. With more than 200 million books sold, the series now covers over 2,700 titles, but surprisingly the subject of economics is not one of them! Therefore, economics for dummies is long overdue. Here is a first edition of it — an essay on Indian economy for dummies to start with. Just take one obvious and undisputed fact and see how the economic establishment looks the other way.
Jobless corporate growth
A study [July 2013] by Credit Suisse Asia Pacific India Equity Research Investment Strategy revealed that after more than two decades of economic liberalisation, the share of the formal sector, (namely the public and private corporate sectors together) in national GDP stood at just 15 per cent and that of listed corporates was just 5 per cent. Despite all the pampering by the government and economists, the formal sector’s share of the nation’s GDP improved by just 3 per cent in more than two decades. In this period, the sector had received foreign investment by debt and equity of over $550 billion and also drew over Rs 18 lakh crore from banks as credit. But how many jobs did it add in this period? Believe it, just 2.8 million! Economists would never mention the huge investment into the formal sector nor the insignificant number of jobs added by it, so that they need not answer either why it produced such jobless growth or ask who else provided the jobs. When I brought this to his notice, a shocked N R Narayanamurthy told me that as the software sector itself had added 3.5 million jobs, it meant that the rest of the corporate sector had actually cut jobs by over 700,000, rather than adding any. Did any economist or prime minister ever speak this hard truth that the big corporates do not provide jobs to the people? Prime Minister Narendra Modi spoke this truth when he unveiled the Mudra finance scheme to the non-corporate sector on April 9, 2015. He said: “People think it’s big industries and corporate houses that provide higher employment. The truth is, only 12.5 million people are employed by big corporates, against 120 million by MSME sector.” He reiterated it when he wrote to small businessmen on April 15, 2015.
Unfunded job rich sector
And where from then did the jobs and people’s livelihood come? The Credit Suisse study says that 90 per cent of the total of 474 million jobs in India is generated by the non-corporate sector which contributes half the national GDP. The study labels this sector in the global language as the informal sector. But it adds that unlike in the West, where the informal sector is largely an illegal sector, in India it is legal business which remains informal only because the government has been unable to reach out to it. The Economic Census (2013-14) says that some 57.7 million non-farming and non-construction businesses yield 128 million jobs. The census classifies them as Own Account Enterprises (OAEs), implying it is self-employment. The census finds that over 60 per cent of OAEs are run by entrepreneurs belonging to Other Backward Castes, Scheduled Castes and Scheduled Tribes; more than half the OAEs and as many jobs provided by them are in rural areas; and nine out of 10 OAEs are unregistered. But this sector, which ensures both social justice and is rich in generating jobs, gets just 4 per cent of its credit needs from the formal banking system and the rest at usurious rates of interest. Here is a paradox. The banks fund corporates which add very little jobs. They are unable to fund the OAEs which generate ten times the jobs the corporates provide.
Citing the Credit Suisse study, The Economist magazine (August 2013) wrote that the best way the Indian informal economy may be formalised is to provide formal finance to them. The capital employed in the 57.7 million units is about Rs 11.4 lakh crore, according to the Economic Census. This informal (cash) financing takes place outside the formal monetary system supervised by the Reserve Bank. The Mudra finance scheme is based on the experience that banks cannot fund this sector. It has devised an innovative method of associating existing large Non Banking Finance Companies providing finance to this sector as National and State Level Coordinators and the small ones as Last Mile Lenders. Without co-opting the existing non-formal finance players, the OAEs cannot be funded.
This innovative effort is being effectively thwarted by a warped bureaucracy — Reserve Bank and the Department of Financial Services acting together. They are effectively scuttling the new Mudra Law promised in the 2015-16 Budget to institute the new financing model. Their objection is that if informal financing is formalised, that would add to the systemic risk. Is allowing close to Rs 12 lakh crore sub-monetary cash economy sourced in black and illegal monies to operate and gain interest rates ranging from 24 to 360 per cent, distorting formal savings, investment, and interest rates not systemic risk? Will the Raghuram Rajans and Department of Financial Services answer? Result, the Prime Minister’s Mudra finance scheme is being delayed, if not stymied by professionals who just want to keep their CV good for their career progress within the guild of economists.
In the second of a three-part series on the Indian economy ahead of the presentation of the Union Budget, well-known commentator on political and economic affairs, S Gurumurthy argues that the Indian family’s instinct to save in banks rather than spend at stores, which is similar to that of Japanese families, has insulated the economy from global crises. However, this cultural aspect has not been given due consideration when it comes to policy and budget-making efforts in the country. This, he explains, is due to the Western bias of Indian economists.
Recall the economic discourse in the 1990s when, threatened by a forex crisis and nearly defaulting on its external debts, India liberalised its economy to allow free foreign investment and foreign trade. The nation was told then that as Indians did not save enough, the economy did not generate adequate capital, and therefore foreign investment was needed for growth. Emphasis was also laid on exports and foreign trade as the main drivers of growth. Looking back from the vantage point of 25 years of liberalisation, it is self-evident now that foreign investment has played but only a secondary role in the Indian growth story. The Indian economy grew primarily through domestic savings, which rose from 21 per cent of GDP in 1991-92 to as high as 37 per cent of GDP in 2009 and now hovers around 31 per cent. Domestic capital formation rose from 22 per cent in 1991-92 to a high of over 38 per cent in 2011-12.
Besides, it is not export but household consumption, close to 60 per cent, which was the mainstay of the nation’s growth. (In contrast, household consumption in China is around 36 per cent, which implies the disproportionately high external dependence of China.) Net foreign investment in India during two decades of liberalisation averaged around 3 per cent of national investment. Foreign investment mainly funded external deficit more than development within. Domestic impulses — in terms of both investment and demand — were therefore the core factors in the Indian growth story, the external forces being additives, though not unimportant. The world began taking notice of India as a domestically driven economy. Additionally, the Global Entrepreneur Monitor Study (2002) found that India (18 per cent) was ahead of China (12 per cent) and US (11 per cent) in entrepreneurship. This helped brand India as entrepreneur-led. But the Indian-establishment economists would still underplay the domestic impulses and speak and celebrate only the role of the external drivers in the Indian growth story.
What is often, if not totally, missed in the Indian discourse, and in the budget making, is the undeniable fact that the household sector is the strongest and stablest component of the Indian economy. Family savings rose from 16 per cent of GDP in 1991-92 to a high of 25 per cent in 2009-10. This is because of the relation-based cultural life that marks India out from the contract-based individualist West. Except for a fraction of ultra-westernised Indians, family is not a contract to live together, terminable at will. It is an integrated cultural institution of mutually dependent persons bound by relationships of caring and sharing. It takes care of the elderly and the infirm, the ill and the jobless, which constitutes its propensity to save. In most of the West, family functions have been taken over by the State through social and health security, which, in substance, means nationalising families.
The families being rid of their relational responsibilities, their propensity to save weakened and consequently the household savings in US which was 80 per cent of US national savings in 1960 nosedived to minus 20 per cent in the third quarter of 2006. Savings turned just a subject of personal choice of the atomised individual and ceased to be a cultural, filial responsibility. The sense of duty to the near and dear, more than one’s own rights, which is inherent in Indian family culture acts as the bulwark against the unbridled individualism of the modern West. It needs no seer to say that culturally India belongs to Asia, not Europe or America. As Barry Bosworth of the Brookings Institution wrote, in Asia savings are dynastic, not personal. The idea of a rational economic man, who acts only in his self-interest, does not apply to Asia or India where filial relations undermine self-interest.
As families in the West were nationalised, traditional government functions like water supply, road building and public utilities, began to be privatised. Significantly, in the US, nationalisation of families and privatisation of government went hand in hand from around the late 1970s. Liberal economic policies, largely imported from the US, have not been able to change the cultural behaviour of Indian families. This was brought out in the Economic Survey 2007-8 (see page 3 Table 1.2/para 1.4). The income-consumption-saving for the period 1981-2 to 2007-8, which covered 10 years of command economy and 16 years of liberal economy demonstrated that the ratio of spending to savings declined from 64 per cent in 1991-2 to 58 per cent in 2007-8 — implying that Indian families have defied consumerist trends encouraged by new economic policies. Noting this fact, the Survey says, “The average growth of consumption is slower than that average growth of income primarily because of rising savings rates.” It concludes: “Year to year changes in consumption also suggest that the rise in consumption is more gradual and steady process, as any sharp changes in income tend to get adjusted in savings rate.”
The behavioural model of Indian households has a lesson for policy makers — that is, shopping is not, and cannot become, central to Indian families. But, in the US, as the famous American anthropologist Marshall Sahlins says shopping is the culmination of modernity. When an Indian household gets extra income it does not go straightaway to the shops. It saves rather than spends it. If the Pay Commission report is implemented, it will not cause instant inflation as the RBI governor seems to fear. This cultural differential is missed in the economic discourse and therefore in policy-making in India.
Similar to Japan, not US
Indian families, generally like Asian ones and particularly like the Japanese, are hooked to banks as the preferred savings vehicle. The bank deposits to GDP ratio in India was 34 per cent in 1992, and is over 70 per cent now — doubling as a proportion of GDP. The Indian stock market yielded a compounded annual return of 14 per cent between 1991 and 2015. Despite that the people have queued up before banks to deposit their savings. The share of equities in the total savings stood at less than 2 per cent in seven out of the 11 years (2004 to 2014). It exceeded 3 per cent only in three years (2007 to 2008) when there was an unprecedented boom in the stock markets. In the four years ending fiscal 2014, the share of stocks in national savings has been less than 2 per cent.
Elite economic thinkers often fault Indian families, which seek safe investment models, as backward and unenlightened. Some even fault them for saving too much. In early 1990s, Dr Jagdish Bhagwati, the India-born US economist, advised the Indian government to make policies to cut family savings by half so their consumption spend would rise. Fortunately, Indian families defied his advice. Actually, as their incomes expanded, Indian families ramped up their savings but maintained their moderate consumption. They lived within their incomes and hardly borrowed to spend. This alone insulated India from the contagion effect of the global crisis in 2008. Had Indian families followed the prescription of experts, they would not have saved as much as they did, which dramatically increased the national investment and GDP. Nor would they have avoided debts that would have risked and even bankrupted them. Indian families compare favourably with Japanese households which too are habituated to save and, like Indians, are also addicted to keeping their savings in banks, not in risky stocks. The economists of the West used to deride the Japanese financial system as inefficient for this reason. But when the monetary crisis hit the West, the Bank of Japan had the last laugh and proudly claimed that the Japanese financial system was safe and sound unlike the Western.
In a paper published in the Bank of International Settlements Site (BIS paper no 46, May 2009) two officials of the Bank of Japan (Shinobu Nakagawa and Yosuke Yasui) wrote: “The average Japanese household has a financial balance sheet that is far more conservative” than that of households in West, with “cash and deposits” representing “half of total financial assets”. In contrast, the ratio for US households is only 16 per cent and in Europe, about one-fourth to one-third. The authors asked, “Why do Japanese households prefer deposits so much over more risky financial assets” when other financial instruments are well-developed and heavily traded in Japan, unlike in some other Asian markets? They answered, “the elderly Japanese were educated to believe that saving through bank deposits was a virtue”. They went on to assert “that the Japanese household sector, far from being a shock originator, is rather a shock absorber” even as they admitted that the risk is therefore “concentrated in the Japanese banking system”, which “continues to be a matter to resolve.”
This is precisely the Indian situation. The risk of financing business is on the Indian banks like it is on the banks in Japan. The Japanese banks, like the Indian ones, also have the same issue of Non-Performing Assets. How they handle the NPA problem will be relevant to India. But the RBI, prone to looking at the West, ignores the Japanese parallel, which is nearer to the Indian filial and financial system. With the result that the RBI is strangulating the Indian economy by applying Western standards when the nation is struggling to come out of almost a decade of economic destruction by the UPA, particularly UPA II. This is a topic by itself.
The author is a well-known commentator on economic and political affairs.
If news reports are to be believed, the Finance Ministry seems to be caving in to the RBI strategy to sell Public Sector Banks and is raising the limits of FDI in banks to 49% — thus virtually paving the way for handing the PSBs, which are at the heart of the national economy, to global financial interests. If the RBI Governor succeeds, it will be a disaster for India.
PSBs, the core
An obvious truth, but, that hardly figures in public discourse, is that Indian financial economy is bank-driven — more precisely, it is Public Sector Bank (PSB) centric. Economic thinkers and policy makers seem to regard the PSBs as a problem, rather than as the most valuable financial asset of Indian economy. It is undeniable that banking in India almost means PSBs, which hold 80% of the deposits of commercial banks. As the Indian economic establishment looks at only the Anglo-Saxon economies, which are market-driven — read equity market — they do not seem to be conscious that the world’s most efficient economy, Germany, too is largely bank-led. Yet another equally efficient economy, Japan, is also equally dominantly bank-led. In both Germany and Japan, unlike in the US or England, stock markets do not have primacy — either to mobilise capital or to distribute it.
>>Related: Indian Economy for Dummies – I
Look at India’s financial structure. Nine-tenths of Indian savings is in safe investment models. More than half of it in banks. The deposits in PSBs amount to over 50% of the GDP. Besides mobilising four-fifths of deposits, PSBs are involved in building financial architecture for formalising the economy on a phenomenal scale, which the private banks cannot even think of. For example, PSBs have opened some 78% of the 20.7 crore accounts under the Prime Minister’s Jan Dhan Yojana (PMJDY).
With Regional Rural Banks accounting for 19% of the PMJDY accounts, private banks contributed just 3% of the accounts. The PSBs’ share of Mudra loans for micro businesses is 60%. Even though bank deposits yield just half as the stocks do, 40% of the Indian household savings move into banks. The celebrated stock market, which offers double the return as the banks, hardly attracts 2% of the nation’s savings. While the public prefer to put their savings in banks, they seem to have enduring trust in PSBs. The Indian economy is not just bank-led, it is PSBs-led. Yet, there is not a word about what good work the PSBs do or about their successes in the economic discourse.
>>Related: Indian Economy for Dummies – II
Worse, the PSBs which are at the heart of the national economy are ceaselessly trivialised, derided and demeaned in the nation’s economic discourse. Their failings are highlighted and their merits suppressed. The dislike for PSBs appears more ideological — and less logical. The main objection to the PSBs is that they are state-owned.
The ideology is that if the PSB ownership is turned private, they will become efficient — because efficient market theory abhors public ownership. It needs no seer to say that the private global banks regarded as the biggest and the best in US had all but declared bankruptcy in 2008. They had to be rescued by government. Private ownership, while it may promote efficiency, does not assure solvency. In fact, their super efficiency itself led to bankruptcy.
Global banking complexity
Recently (Feb 16, 2016), Bloomberg wrote a chilling analytical story titled, “The European Banks face a frightening future”. They are all celebrated global banks — Royal Bank of Scotland, Barclays, UBS, Credit Suisse, Deutsche Bank, UniCredit and Standard Chartered.
But they had laid off close to 75,000 employees since 2008. In 2008, the experts said that the crisis happened because of lack of regulation. According to Bloomberg, now the banks say that, “regulation has made the world more dangerous”. The chairman of the Eurogroup, made up of Euro area’s finance ministers, countered, “Don’t say we have over regulated the banks” adding that it is the opposite, as what is impeding economic recovery are “the effects of a financial crisis” which was “not caused by over regulation”.
The truth is that the banking industry in the West has become complex. The truth again is that they are struggling over how to become simple again! Say Bloomberg analysts: “In the end, the banking industry troubles can be traced to one thing — the cost of complexity. From the moment the banks went global in the late 1990s, skeptics decried these behemoths are too big to manage, let alone too big to fail. But the institutions thrived on the very creation of complexity in their products and in the markets.”
Former Deutsche Bank CEO Josef Achermann said, “There’s once again a flight to simplicity. That is what the regulators are demanding… The unbundling of banking services is undoubtedly complicated and perhaps even fraught with unseen dangers. And it is really all about getting back to basics.” There is a message for India in the Bloomberg report. What is the problem of these banks? They are not banks as the Indian economy or people or law understand. Indian law defines banking as “accepting for the purpose of lending or investment of deposits of money from the public”. This is simple banking. If these global giants, who had complicated the idea of banking and messed up themselves, their and world economy, bought out the PSBs, would they manage them better? Or mess them up as they have messed up themselves?
Sledge hammer approach
The RBI is applying the Basel banking norms developed for the complex banking business of the West on the Indian banking system which is simple but highly regulated. Applying Western banking norms for provisioning for Non-Performing Assets (NPAs) in Indian banks is to apply the rules of the rogue Western game of Rugby for the simple local game of Kabaddi. One simple differential is sufficient to show how inappropriate are the provisioning rules of Western banking to Indian banks. The provisioning rules are intended to ensure that depositors and investors are protected.
The Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) together absorb and protect 27.5% of bank deposits. Actually, Indian banks’ investment is almost close to 30% in government securities. Therefore, over 35% of the bank deposits are protected by government securities. Nowhere in the world such actual security cover is available to depositors. Again, the Indian banks protect and de-risk themselves by personal guarantees and collaterals. None of these realities are reckoned by the RBI in devising its “sledge hammer approach”, as a leading banker described Raghuram Rajan’s fiat to banks — particularly PSBs — to provide for stressed assets or get lost.
RBI looks to West
What is the extent of NPAs which is making the RBI governor restless? A report in the Forbes magazine (Feb 16, 2016) says, quoting Credit Suisse, that the NPA levels of Indian banks would move to 6.6% by March. The Indian banks have reported much higher NPA levels in the past. NPAs remained around 8-9% from 2003 to 2011. Thereafter, it began declining — to 6.5% in 2012, 4.5% in 2013 and 4.9% in 2014. When the economy was doing very well between 2003 and 2011, the NPA levels have been far higher.
The sledge hammer approach should have been adopted then, when the banks and the economy could well have absorbed it. Nations pass through such phases. The NPAs in Japanese banks ranged from 8% to 9% in the 1990s till 2001 and it was 7.5% in 2002 (BIS paper No 46 May 2009) and only thereafter, it began to fall. Despite the NPAs exceeding a $ trillion, the Bank of Japan did not take the sledge hammer in hand, like Rajan is doing.
The Japanese banks, which were all private, were not writing off bad loans because of inadequate capital — like the PSBs. Yet, the banks were not compelled to provide for bad loans, because that would have caused imminent crisis of confidence in the banking system. The government stepped in to support the banks with public funds to the extent of 30 trillion yen. Whenever private banks face crisis, the government becomes the ultimate saviour. This was true of the Japanese banking crisis of 1990s and of the US financial crisis of 2008. When the State steps in, confidence gets restored in private banking. That is not the case here. There are three critical differentials which are the protective walls of the Indian financial system and Indian economy.
First, there is no capital account convertibility which will expose Indian banking to global finance. Next, India has rightly not opened the banking system to foreign investment. Third, PSBs are state-owned. These three basic facts ensure that PSBs face no imminent threat. Threat to banks from NPAs is imminent when they are privately owned; they are open to foreign ownership and the currency is full convertible. Disregarding the basic strengths of the PSBs, Rajan appears to turn a prudential issue into a banking crisis. Would Rajan have taken the sledge hammer if the PSBs were privately owned? He would never have because that would have set off a banking crisis. Is he then doing it only because the PSBs are state-owned banks?
Design to sell PSBs to foreigners?
The RBI’s NPA policy appears to be more the outcome of an ideological accountant’s mindset than the product of a practical banker’s wisdom. When the world over, central banks are buying stressed assets and junk bonds held by banks to de-stress the banks and make them carry on their business, Rajan is doing precisely the opposite. He is coercing the banks to provide for NPAs, when he knows that they do not have the surplus to absorb the loss.
It means the banks will need to be recapitalised to the extent of losses. Here Rajan goes one step further and virtually makes it impossible for the government to recapitalise. He is morally coercing the government to meet the fiscal targets. That is not his domain. That is the sovereign business and Parliament’s function. He knows that if the government were to cut fiscal deficit, it cannot recapitalise the PSBs. Is he then compelling the government to privatise the PSBs? That is, forcing the government to sell them to foreign banks as the scale of capital needed to buy the PSBs is not available with private corporates in India.
If news reports are to be believed, the finance ministry seems to be caving in to the RBI strategy to sell PSBs and is raising the limits of FDI into banks to 49% — thus virtually paving the way for handing the PSBs to global financial interests. If Rajan succeeds, it will be a disaster for India. But it is bound to do good for Rajan, as the world of free market will idolise him for privatising and globalising the hardcore of Indian financial system — the PSBs. His CV will become the most sought after when he retires in the coming winter. Why then should he bother about what happens to India? But surely, the Modi government should be bothered about India. Isn’t it?